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Dematerialized securities are securities that are not on paper and
a certificate to that effect does not exist. They exist in the
form of entries in the book of depositories. Essentially, unlike
the traditional method of possessing a share certificate to the
effect of ownership of shares, in the demat system, the shares are
held in a dematerialized form. This system works through a
depository who is registered with the Securities and Exchange
Board of India (SEBI) to perform the functions of a depository as
regulated by SEBI.
Under Section 68 B of the Companies Act, inserted by the Companies
(Amendment) Act, 2000, it is mandated that every initial public
offer made by a listed company in the excess of Rs 10 Crores has
to be issued in dematerialized form by complying with the
requisite provisions of the Depositories Act, 1996.
Depository system
A major weakness in the Indian stock market has been the lack of
depository services on modern lines . Depositories provide for
maintenance of ownership records in a book entry form. Before the
Depositories Ordinance introduced the depositories system in
India, every share transfer required to be accomplished by a
physical movement of share certificates to, and the registration
with the company concerned.
The two models of the depository system
are:
1. Dematerialization, wherein,
by operation, there is no physical scrip in existence as neither
the individual who owns the shares nor the depository keeps scrips.
The depository maintains the electronic ledger of the securities
under his control.
2. Immobilization, wherein the
physical scrips are held in the depository vaults, supporting the
book entry records kept on the
computer.
Two types of ownership are contemplated
under the depository system and can be briefly put forth as
follows:
1. A registered owner is the
depository who holds the securities in his name.
2. A beneficial owner is the
person whose name is recorded as such with the depository. Though
the securities are registered in the name of the depository
actually holding them, the rights, benefits and liabilities in
respect of the securities held by the depository vest in the
beneficial owner.
The depository model is based on the deposit of securities by the
owner of the securities with a certified depository. Subsequently,
an entry is made in the name of the said owner, manifesting his
ownership of the securities upon which the person depositing the
securities becomes the beneficial owner in respect of the said
securities. The service provided in relation to this by the
depository is that of recording of allotment of securities or
transfer of ownership of securities in the
record of the depository .
Process of conversion of securities into
the demat form
Securities specified as being eligible for dematerialization by
the depository in its bye laws and as under the SEBI (Depositories
and Participants) Regulations, 1996 (the Regulations) can be
converted or issued in a dematerialized form. The process of
conversion of securities into a dematerialized form or the
issuance of the same in a dematerialized form can be explained
thus:
1. Firstly, the issuer
company, whose securities are eligible for dematerialization, has
to enter into an agreement with a depository for dematerialization
of securities already issued, or proposed to be issued to the
public or existing shareholders .
2. The investor is given an
option to hold the securities in a dematerialized form and it is
his prerogative to exercise the option to hold the securities in
that manner.
3. The depository enters into
an agreement with the participants who are the agents of the
depository and co-functionaries in the process of
dematerialization of securities .
4. Any person can then enter
into an agreement, through the participant, with the depository
for availing the services provided by the depository.
5. Upon the entering into such
agreement with the depository, the person has to surrender the
certificate pertaining to the securities sought to be
dematerialized to the issuer. This surrender is effected in the
following manner:
(i) The person (beneficial
owner) who has entered into an agreement with the participant for
dematerialization of the securities has to inform the participant
about the details of the certificate of such securities.
(ii) The beneficial owner has
to then surrender the said certificate to the participant.
(iii) The participant informs
the depository about the particulars of the securities to be
dematerialized and the agreement entered into between him and the
beneficial owner.
(iv) The participant then
transfers the certificate pertaining to the said securities to the
issuer along with the details and particulars of the securities.
(v) These certificates are
mutilated upon receipt by the issuer and substituted in the
records against the name of the depository, who is the registered
owner of the said securities. A certificate to this effect is sent
to the depository and all stock exchanges where the security is
listed.
(vi) Subsequent to this, the
depository enters the name of the person who has surrendered the
certificate of security as the beneficial owner of the
dematerialized securities.
(vii) The depository also
enters the name of the participant through whom the process has
been carried out and sends an intimation of the same to the said
participant.
6. Once the aforesaid process
of dematerialization is carried out, the depository has the
responsibility to maintain all the records pertaining to the
securities that have been dematerialized.
Advantages of Dematerialization
The advantages of dematerialization of securities can be
summarized as
follows:
A. Share certificates, on
dematerialization, are cancelled and the same will not be sent
back to the investor. The shares, represented by dematerialized
share certificates are fungible and, therefore, certificate
numbers and distinctive numbers are cancelled and become
non-operative. The depository system and dematerialized securities
offer paperless trading and transfer of shares through the use of
technology.
B. It enables processing of
share trading and transfers electronically without involving share
certificates and transfer deeds, thus eliminating the paper work
involved in scrip-based trading and share transfer system.
C. Transfer of dematerialized
securities is immediate and unlike in the case of physical
transfer where the change of ownership has to be informed to the
company in order to be registered as such, in case of transfer in
dematerialized form, beneficial ownership will be transferred as
soon as the shares are transferred from one account to another.
D. The investor is also
relieved of problems like bad delivery, fake certificates, shares
under litigation, signature difference of
transferor and the like.
E. There is no need to fill a
transfer form for transfer of shares and affix share transfer
stamps.
F. There is saving in time and
cost on account of elimination of posting of certificates.
G. The threat of loss of
certificates or fraudulent interception of certificates in transit
that causes anxiety to the investors, are
eliminated.
Disadvantages of Dematerialization
The disadvantages of dematerialization of securities can be
summarized as follows:
A. Trading in securities may
become uncontrolled in case of dematerialized securities.
B. It is incumbent upon the
capital market regulator to keep a close watch on the trading in
dematerialized securities and see to it that trading does not act
as a detriment to investors. The role of key market players in
case of dematerialized securities, such as stock-brokers, needs to
be supervised as they have the capability of manipulating the
market.
C. Multiple regulatory
frameworks have to be confirmed to, including the Depositories
Act, Regulations and the various Bye Laws of various depositories.
Additionally, agreements are entered at various levels in the
process of dematerialization. These may cause anxiety to the
investor desirous of simplicity in terms of transactions in
dematerialized securities.
However, the advantages of dematerialization outweigh its
disadvantages and the changes ushered in by SEBI and the Central
Government in terms of compulsory dematerialization of securities
are important for developing the securities market to a degree of
advancement. Freely traded securities are an essential component
of such an advanced market and dematerialization addresses such
issues and is a step towards the advancement of the market.
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Authored by trinath tadakamalla and can be reached at :
trinath@mail.com
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